Application of Risk-Based Audit Approach by Sole Practitioners and Local Audit Firms: Towards Fully-Compliant Financial Reports

Rowell S. Cardenas¹, Dr. Regina D. Ramel²

^1,2School of Graduate Studies – Saint Mary’s University – Bayombong, Nueva Vizcaya

ABSTRACTS: The study examined the factors influencing the implementation of the Risk-Based Audit Approach (RBAA). Key variables identified were auditor capability, availability of audit professionals, integration of information technology, job pressure on auditors, competitiveness of audit firms, and audit fees. The respondents included sole practitioners and employed auditors in local audit firms. The research used a quantitative method, employing structured questionnaires to capture respondents’ perceptions. The findings revealed that auditor capability is the most critical factor in applying RBAA. For effective implementation, auditors need industry-specific experience, sufficient training hours, balanced staffing leverage, investment in IT and productivity tools, compliance with firm regulations, and a good ratio of audit hours to risk areas and audit phases. Skilled auditors are more adept at identifying and addressing potential issues. Future research could explore factors affecting auditor capability and the availability of audit professionals.

KEYWORDS: Audit Procedures, Audit Methodology, External Audit, Risk-Assessment.

INTRODUCTION

The primary role of external auditors, whether as partnership audit firms or sole audit practitioners, is to provide reasonable assurance that the financial reports prepared by management are free from material misstatement and are fully compliant.^I In this regard, the study focuses on determining the factors that influence the application of the Risk-Based Audit Approach (RBAA), which are essential in providing fully compliant financial reports along with the auditor’s capability, availability of audit professionals, IT support, job pressure on auditors, competitiveness of audit firms, and audit fee.

Various audit approaches can be utilized when conducting an external audit of financial statements. These audit approaches include substantive procedures, balance sheets, systems-based, and risk-based audits as defined by the Association of Chartered Certified Accountants (ACCA) in its qualification papers issued in February 2008. Business risk auditing is the modern approach that shifts the focus of the audit process from the financial system to the whole client’s environment.^II In this regard, applying a risk-based audit approach could help enhance the quality of audits performed by auditors as it addresses the client’s financial system and the client’s overall risks.

The international standards on auditing provide three steps to risk-based audit. The initial step involves evaluating the client’s business risk. Next, assess the risk of material misstatement. Finally, respond to the identified risks. The last is to report or provide an opinion on the risks assessed.^III These steps serve as a guide for the researcher as to the application of a risk-based audit approach. In addition, the client’s business risks should be identified with the risk of material misstatement.

Various corporate failures, such as the Equity Funding Corporation of America in 1977 and Enron and WorldCom in 2002, have prompted the creation of numerous government regulations governing audit practices. Examples include the Sarbanes-Oxley Act of 2002, the establishment of the Public Company Accounting Oversight Board (PCAOB), and the Quality Assurance Review (QAR) by the Professional Regulation Commission – Board of Accountancy (PRC-BOA). Auditors must ensure compliance with these regulations. Additionally, the Auditing and Assurance Standards Council has adopted Philippine Standards in Auditing (PSA) 315 (Revised 2019), which focuses on determining and evaluating the risks of substantial misstatement. To further assess a corporate entity’s risks, auditors need to understand the entity and its business strategy, which a risk-based approach directly addresses.

The United Nations recently issued seventeen Sustainable Development Goals (SDGs). Among these SDGs are the goals related to quality education (SDG 4), industry, innovation, and infrastructure (SDG 9), and peace, justice, and strong institutions (SDG 16). Understanding the influence of factors related to risk-based audit approach application can help address the mentioned sustainable development goals. Ultimately, all auditors are affected by the adoption by the Assurance and Auditing Standards Council of the Revision of the International Standards on Auditing (ISA) 315, which requires the auditors to understand the entity and its business model further.

Research Framework

Fig. 1 (Factors Influencing RBAA)  (SEE IN PDF FILE)

Risk Based Audit Approach can be influenced by several factors, namely, the auditor’s capability, the availability of audit professionals, the IT support, the job pressure on auditors, the competitiveness of audit firms, and the audit fee.

Auditor’s Capability

In this study, Auditor Capability encompasses the auditor’s experience in auditing and specific industries, turnover, training, and qualifications. Auditor experience is quantified by the number of years within the audit firm and the auditing profession, while industry experience is measured by the years spent working in a particular industry. Turnover refers to the movement of audit personnel between engagements or firms. Auditor training includes relevant training sessions, such as in-house training provided to audit professionals. Qualifications are determined by whether the auditor holds a Professional Regulation Commission (PRC) license and their highest level of educational attainment. Additionally, an auditor’s capability to use Computer-Assisted Audit Techniques (CAATs) is measured by their years of experience with these tools.

Availability of Audit Professionals

In this study, the availability of audit professionals indicates the staffing leverage, the partner, manager, and staff workload, the technical accounting resources, and the expert services. Staffing leverage calculates the time auditors spend on the amount of audit work they supervise or perform. Partner workload measures the time the partner or the sole practitioner gives to each audit engagement. Staff workload measures the time the manager and audit staff give when conducting the audit procedures. Technical accounting and auditing resources measure the availability of persons or other resources advising on complex, unusual, or unfamiliar issues. Persons with specialized skills and knowledge assess how an audit firm uses persons with specialized skills while conducting an audit.

IT Support

The lack of statistical methods prevents risk-based auditing performance.^IV Therefore, to effectively apply RBAA, audit firms should invest in statistical tools for use during audits, enhancing audit effectiveness. Technological advancements in business are essential, impacting the audit environment. Consequently, applying information technology to audit activities is also an indispensable trend.^V Providing the auditors with computer technology equips them with various techniques for examining the automated business environments.^VI The use of Computer-Assisted Audit Tools (CAATs) could also assist in applying RBAA, enabling the auditors to conduct audits more effectively. ^VII In this study, IT support is measured by the investment made by audit firms and sole practitioners in CAATs, IT auditing, audit statistical tools, commercial audit software, and productivity tools.

Job Pressure on Auditor

In line with the implementation of ISA 315 and ISA 520, there has been an increase in audit firms implementing RBAA.^II This means that government and professional regulations can influence audit firms’ application of RBAA. On the other hand, the lack of standards related to the conduct of RBAA is one of the constraints when applying it.^VIII  Additionally, the pressure from users of audit reports, who expect auditors to detect fraud and errors and handle audit findings effectively, impacts the application of RBAA.^IX This pressure suggests that users of financial statements have greater confidence in those audited using RBAA.^X Furthermore, the allocation of audit hours to identified risk areas and audit phases is crucial for the effective application of RBAA.^IV In this study, job pressure on auditors refers to the regulations of government, professional, and audit firms, as well as the distribution of audit hours to the risk areas identified, and audit phases.

Competitiveness of Audit Firms

One of the primary reasons audit firms do not adopt the Risk-Based Audit Approach (RBAA) is due to constraints on audit resources.^XI Therefore, the size of the audit firm can influence its application. Larger and more reputable audit firms have a competitive advantage when applying RBAA. The structure and performance of auditors and audit firms can also be obstacles to implementing RBAA. Thus, the competitiveness of audit firms affects the application of RBAA. In this study, the competitiveness of audit firms is defined by their size, reputation, and client size. The size of an audit firm measures the total available audit resources, its reputation reflects the firm’s trademark, and client size measures the size of the firm’s audit clients.

Audit Fee

The potential benefits of applying the Risk-Based Audit Approach (RBAA) do not justify the additional costs due to low audit fees. If audit fees increase beyond acceptable levels, it can compromise the entity’s independence and affect the quality of the audit. In this study, the audit fee is determined by the auditor’s engagement compensation, out-of-pocket expenses, and the alignment of the audit fee with the client’s risk and size.

Statement of the Objectives

The study aimed to identify the factors influencing the application of a risk-based audit approach among audit firms and sole practitioners in Isabela, Philippines. Specifically, it focused on determining the impact of the following factors:

Auditor’s capability

Availability of audit professionals

Information technology (IT) support

Job pressure on auditors

Competitiveness of audit firms

Audit fee

DESIGN AND METHODOLOGY

The research employed a quantitative-descriptive design, gathering quantitative data through a Likert-scale questionnaire with checklist questions to gain a comprehensive understanding of the phenomenon. This design was used to assess the impact of auditor capability, availability of audit professionals, IT support, job pressure on auditors, competitiveness of audit firms, and audit fees on the application of the Risk-Based Audit Approach (RBAA).

The research was conducted in Isabela, Philippines, focusing on audit practitioners either working as sole practitioners or employed in partnership audit firms within the province. The study population included audit practitioners working as associates, senior associates, managers, or partners in these firms. Respondents comprised engagement teams from partnership audit firms and sole audit practitioners, aged between 21 and 60 years, who provided valid informed consent. Exclusions were made for those not fit or healthy enough to participate and elderly sole practitioners. Withdrawal requests were honored under valid circumstances. The respondents included 10 sole practitioners and 25 audit practitioners from two partnership audit firms, CLTA & Co. and Alas Oplas & Co., CPAs.

The demographic profile of the study was analyzed using descriptive statistics utilizing the frequency, percent, mean, and standard deviation. The researcher used mean and standard deviation to determine the influence of the abovementioned factors on the risk-based audit approach. The domains were then ranked based on their mean to identify which of the domains greatly influence the application of risk-based audit approach.

III.  RESULTS

Table I. Influence of Auditor’s Capability to RBAA.

The auditor’s capability is perceived as very influential in applying a risk-based audit approach (RBAA) (m=3.51, s=0.23). Among the sub-factors, Industry Experience is the most influential (m=3.80, s=0.41). On the other hand, Audit Turnover, although still influential, has the most negligible influence among the sub-factors (m=3.23, s=0.65). Moreover, auditor’s experience and training hours are also very influential to risk-based audit approach (m=3.60, s=0.50) (m=3.69, s=0.47).

Table II. Influence of Availability of Audit Professionals to RBAA.

Legend: 1.00-1.49: Not at all influential, 1.50-2.49: Not Influential, 2.50-3.49: Influential, 3.50-4.00: Very Influential

The availability of audit professionals is perceived as influential in applying a risk-based audit approach (RBAA) (m=3.45, s=0.17). Among the sub-factors, Staffing leverage is the most influential (m=3.66, s=0.48). Conversely, while influential, the auditor’s workload has the most negligible influence among the sub-factors (m=3.29, s=0.71). Additionally, the availability of technical resources is very influential to the effective implementation of RBAA.

Table III. Influence of IT Support to RBAA

Information Technology is perceived as influential in applying a risk-based audit approach (RBAA) (m=3.44, s=0.15). Among the sub-factors, Investment in IT Auditors is the most influential (m=3.57, s=0.50). On the other hand, Investment in Commercial Audit Software, although influential, has the least influence among the sub-factors (m=3.20, s=0.58). Moreover, investment in statistical tools is very influential in applying RBAA.

Table IV. Influence of Job Pressure on Auditors to RBAA.

Job pressure on auditors is perceived as influential in applying a risk-based audit approach (RBAA) (m=3.42, s=0.17). Among the sub-factors, audit hours to Phases of Audit is the most influential (m=3.60, s=0.65). On the other hand, although influential, Government Regulation has the least influence among the sub-factors (m=3.20, s=0.58). Furthermore, audit firm regulations and audit hours to risk-areas are very influential to the application of RBAA.

Table V. Influence of Competitiveness of Audit Firms to RBAA.

The competitiveness of audit firms is perceived as influential in applying a risk-based audit approach (RBAA) (m=3.24, s=0.24). Among the sub-factors, Having Audit Methodology is the most influential (m=3.40, s=0.60). On the other hand, Market Share, although still influential, has the least influence among the sub-factors (m=2.89, s=0.30).

Table VI. Influence of Audit Fee to RBAA.

Audit Fee is perceived as influential in applying a risk-based audit approach (RBAA) (m=3.30, s=0.23). Among the sub-factors, audit fee to client size is the most influential (m=3.46, s=0.74). On the other hand, although still influential, Engagement Fee has the least influence among the sub-factors (m=2.97, s=0.95).

DISCUSSION

Auditor’s Capability

Auditors with industry experience are familiar with the unique risks and challenges that specific industry experiences. Moreover, auditors with client-specific experience better understand clients’ risks, allowing the team to respond to these risks better and provide more value-added services.^XIII These factors enhance the effectiveness of applying RBAA.

Information from rolling audit planning by previous auditors, combined with ongoing audit engagements, helps improve the company’s understanding of the risk landscape, allowing auditors to focus on high-risk areas.^XIV The high turnover rate of auditors also influences the application of RBAA as new employees have to be trained, and typically, it takes a substantial period before they get accustomed to applying RBAA. The previous engagement will make it easier for the auditor to conduct further examinations and improve auditor competence.^XV However, by establishing audit methodologies and procedures, adequate documentation and knowledge transfer, and effective supervision and quality control, even with turnover, risk-based auditing remains consistent, minimizing the impact of personnel changes.

Availability of Audit Professionals

Efficient staffing allows for optimal allocation of resources. By leveraging staff appropriately, audit teams can focus their efforts on high-risk areas, ensuring that critical risks are addressed while minimizing time spent on lower-risk areas, which is the essence of RBAA. Audit deficiencies have made it clear that one primary reason is not having the right players on the team.^XVI

An auditor’s heavy workload has negative consequences on audit processes.^XVII While workload is a consideration, it is not a primary driver of a risk-based audit approach. RBAA focuses on the quality and relevance of audit procedures over the quantity of work performed by associates and managers.

IT Support

Investing in IT auditors is highly influential in applying RBAA, as they bring specialized expertise in information systems, cybersecurity, and data analytics. This expertise is crucial for identifying and assessing IT-related risks, which are increasingly significant in today’s audit landscape.^XVIII Moreover, the technology landscape constantly evolves, bringing new risks and challenges. IT auditors are well-equipped to adapt to these changes and update the risk assessment process accordingly.^XIX

Using sophisticated technology and data analytics is fast becoming a standard operating practice.^XX While audit software can assist in enhancing the effectiveness and efficiency of specific audit tasks, it is not the primary driver of RBAA. The core of a risk-based audit approach relies heavily on the expertise and judgment of auditors to identify and assess risks. Although this software can assist, it cannot replace the nuanced understanding and professional skepticism that human auditors can bring.

Job Pressure on Auditors

Allocating audit hours to different phases of the audit is crucial in an RBAA, as it ensures a thorough risk assessment, leading to the proper identification of risk areas and the design of suitable audit procedures.

Regulatory compliance serves as a cornerstone of audit practice, shaping the methodologies employed by auditors to provide assurance of the reliability of financial information.^XXI While government regulations are important, they are seen as the least influential factor in RBAA application because the approach aims to provide a comprehensive review of the organization’s risk profile. This holistic view encompasses, but is not limited to, regulatory risks, ensuring all significant risks are effectively identified and managed.

Competitiveness of Audit Firms

Having an audit methodology is crucial for applying RBAA, as it provides a structured framework that guides auditors through the entire audit process. This ensures consistency and thoroughness in identifying and assessing risks across various organizational areas. An audit methodology helps systematically identify and assess risks, ensuring auditors focus on areas with the highest risk of material misstatement and operational failure.

While the market share of the audit firm is influential, it is the least significant among the sub-factors. The RBAA approach is fundamentally tailored to the specific risks of the client being audited, emphasizing adherence to standardized methodologies and the auditor’s independence and objectivity rather than focusing solely on the audit firm’s market share.

Audit Fee

Audit fees are considered a significant issue limiting the application of RBAA.^XXII The audit fee-to-client size ratio is very critical when applying for RBAA. Ensuring that the audit fee is proportionate to the client’s size and complexity is crucial. Underpricing an audit can lead to insufficient audit procedures, increasing the risk of material misstatement being undetected. Moreover, a high fee relative to size might indicate that the client operates in a high-risk industry or has complex financial transactions requiring more audit procedures.

In an RBAA, although influential, engagement fees are the least among the sub-factors. This shows that the audit approach is independent of the engagement fee to be received, as regulatory and professional standards bind auditors. Auditors must adhere to standards emphasizing the importance of risk assessment and mitigation. These standards guide the audit process, ensuring that financial considerations do not compromise it.

CONCLUSION

Among the factors influencing the Risk-Based Audit Approach (RBAA), auditor capability is the most influential. To ensure effective implementation of RBAA, auditors should have comprehensive and industry-specific experience, allocate adequate training hours, balance staffing leverage, invest in IT auditors and productivity tools, comply with audit firm regulations, and maintain an appropriate ratio of audit hours to risk areas and audit phases.

To effectively apply a risk-based audit approach, enhancing auditor capability is essential. As such, the following actionable strategies are deemed necessary for audit firms, sole practitioners, and professional organizations: First, develop mentorship programs where experienced auditors guide less experienced ones, facilitating knowledge transfer and practical insights into risk-based auditing. Second, conduct regular audit simulations to prepare auditors for various risk scenarios, enhancing their problem-solving skills. Professional organizations can also incorporate these simulations into national conventions. Third, establish feedback mechanisms where auditors receive constructive feedback on their audit performance, promoting continuous improvement within the team. Fourth, develop internal or external knowledge-sharing platforms where auditors are informed about the latest auditing trends, regulatory changes, and industry standards. Moreover, the Board of Accountancy should strengthen the Quality Assurance Review to focus also on sole practitioners and auditors in the provinces to help them identify areas for improvement. Finally, conducting regular internal and external audit quality reviews can help auditors identify areas for improvement and ensure that risk-based audit practices are being applied effectively.

ACKNOWLEDGMENTS

The researchers would like to thank the Saint Mary’s University – School of Graduate Studies, Bayombong, Nueva Vizcaya.

VII.  DISCLOSURE

The researchers declare no conflict of interest in this study. The researchers have no personal gain from doing this research, which could affect the integrity of its result. The researchers declare that no funding from any internal or external sources was received during the study.

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